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Layoffs Leave Everyone Worse Off

September 15th, 2011


The script for a layoff announcement in America these days is numbingly predictable, whether delivered by email or live at a beleaguered head office: The CEO reviews the tough economic landscape facing the firm, promises that “our employees will remain our most valued asset,” then announces that 10% or 15% or more of the workers will be let go while claiming that “I had no other option.”

Given the financial and emotional carnage that layoffs have inflicted during the Great Recession — on workers, their families, communities, the whole country — it would be reassuring to know two things: first, that those CEOs could justify exactly how a layoff was going to forestall impending economic disaster; and, second, that they really had explored all their options.

Sadly, there is little evidence that either of those things take place in most boardrooms across America.

The Alleged Efficiency of Layoffs

There are legitimate alternatives to layoffs. Consider Cleveland-based Lincoln Electric (LECO) — a company that has not given a single employee a permanent pink slip for economic reasons since 1948. Lincoln found other ways to go lean, like reducing hours, instituting hiring freezes, and offering early retirement incentives to volunteers.

Lincoln’s no-layoff policy is the outlier in corporate America. It shouldn’t be.

Evidence is mounting that layoffs represent an extraordinarily risky and costly business strategy. Far too few executives are aware of what they unleash on their own firm when they downsize or rationalize (or whatever other antiseptic euphemism they have for destroying people’s lives).

Peter Cappelli — from the University of Pennsylvania’s Wharton School, and a leading expert on layoffs — is depressingly blunt about the layoff thought process used by the majority of CEOs in America: He says most have absolutely no idea if cutting employees is a good strategy.

“They don’t have a systematic way to assess what is the net present value of the decision whether or not to lay people off,” he says. Yet these same executives can make detailed calculations for virtually every other decision that comes across their desks.

The Real Cost of Pulling the Layoff Lever

Given the apparent ease with which those running U.S. businesses have been pulling the layoff lever, we should demand that they think more rigorously — and much further ahead — about these issues than they do now.

CEOs should start by examining the actual costs of reducing headcount in tough times. Calculating the impact of a layoff on the morale of those who survive is hard, but not impossible.

Increasingly, research demonstrates that the stress on those left to pick up the slack leads to higher costs in the long run. The survivors wonder, “Am I next?”; instead of waiting for the answer, they head for the exits. It’s not uncommon that, for every worker formally laid off, up to five more voluntarily decide to leave within a year.

And what happens when business starts to pick up again? Employers find themselves understaffed — and scrambling to survive. The costly race to recruit and hire replacements can easily wipe out the expected savings used to justify the initial layoff.

Employee morale isn’t all that suffers when workers are let go. When remaining workers live in fear for their jobs, does anyone rationally expect the quality of production not to deteriorate?

It happened to Caterpillar (CAT) in the 1990s, when the company endured near-continuous labor strife. Caterpillar’s customers (and who counts more?) consistently rated the quality of the firm’s tractors and heavy equipment produced in those years as significantly lower than normal.

The cost of that loss of confidence is estimated to have been nearly half a billion dollars — and that’s not the kind of money shareholders can just let slide.

Who Really Makes Money When Heads Roll?

“A layoff will protect our stock valuation” is one of the perverse justifications CEOs use when trotting out their plans to shareholders and analysts. Yet, increasingly, research shows that it’s simply untrue.

A study by Bain and Company found that while very small layoffs may have little effect on share value, a public company that slashes 10% or more of its workforce — and that’s not rare! — will see its stock drop nearly 40% in value, and that it may take years to recover. (Take note, Research In Motion (RIMM) shareholders — the BlackBerry maker cut 10.5% of its workforce this summer.)

Another global review of the effect of layoffs on stock valuations is equally grim: “[L]ayoff announcements have an overall negative effect on stock prices … whatever the country, the time period or the type of firm considered.”

So, we know layoffs are horrible for those who lose their jobs. And we also know that cutting workers doesn’t reward shareholders. So who wins when heads roll? You probably won’t be shocked at the answer to that question.

Cut Headcount, Boost Paycheck

Researchers at the University of Arkansas tracked the earnings of executives at major U.S. corporations who ordered 229 layoffs during the 1990s. A year after the layoff, average total CEO compensation was up 23%!

Granted, the ’90s was a decade of growth. Now, however, the growing chasm between bloated CEO earnings and poor corporate performance (which clearly includes ordering a layoff) is fueling widespread public suspicion that far too many compensation systems are badly skewed in favor of those at the top. (Check out William Lazonick’s work on this issue.)

Lacking convincing evidence that layoffs represent an effective long-term business strategy — even in emergencies — it’s time to get much tougher on corporate leaders who claim that they have no other option.

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